October 25th rate cut "a done deal"? Nomura: Market underestimates the weakness of the Eurozone economy

As the Eurozone's economic slowdown intensifies, market attention is focused on the European Central Bank's interest rate decision on the 17th of this month, with expectations of a rate cut rising.

On the 9th, Nomura Securities pointed out in a research report that although the market has gradually reflected expectations of a slowdown in the Eurozone economy, the risks of an economic recession and the scale of the ECB's rate cut cycle are still underestimated.

Nomura predicts that the European Central Bank will cut the deposit rate by 25 basis points to 3.25% in October, and expects a total rate cut of 175 basis points by 2025.

Goldman Sachs holds a similar view on the ECB's October rate decision, and believes that weak European economy, weakening inflation pressures, and the ECB's dovish stance support the rate cut.

Nomura: Market Underestimates Eurozone Recession Risk

Nomura's outlook for the Eurozone economy is rather pessimistic, believing that the market underestimates the possibility of a recession.

While mainstream economists expect a 30% probability of a Eurozone recession in the next 12 months, Nomura raises this probability to 40%. The bank points out that unless the Eurozone labor market rapidly loosens (such as companies stop hoarding labor) or there is a sudden escalation in geopolitical tensions, the direct triggers for an economic recession in the short term are not obvious.

The report notes that the forward market expects the ECB's deposit rate to fall below neutral levels in the next two years. Based on the spread between 1-year and 5-year forward rates, the market believes that the ECB needs to maintain loose monetary policy to address downside risks to economic growth.

Currently, this spread is -30 basis points, and before the release of the US labor market report, this gap had once approached 50 basis points.

However, Nomura believes that in a soft landing scenario, policy rates will fall back to neutral levels, not below neutral levels.

The market is pricing neutral rates too high (5-year 1-year forward rate = 2.45%), and as inflation pressures continue to weaken, this will become increasingly apparent. We are increasingly convinced that neutral rates may be lower than market expectations.

Nomura expects that consumer growth in the Eurozone will weaken in 2024 and 2025, with the Eurozone economy growing by only 0.7% in 2024 and slightly rebounding to 1.0% in 2025.

Rate Cut Next Week a "Done Deal"? Nomura: ECB May Start Continuous Rate Cuts, Euro and European Stocks Under Pressure

Previously, several ECB officials advocated for a 25 basis point rate cut in October. ECB President Lagarde stated that confidence in controlling inflation has strengthened. Nomura believes that the ECB will adopt a steady rate cut strategy in the upcoming policy cycle to address the slowdown in growth and easing inflation pressures.

Nomura predicts that the European Central Bank will cut the deposit rate by 25 basis points to 3.25% on October 17th. This decision is mainly due to lower-than-expected September HICP (Harmonized Index of Consumer Prices) inflation, deteriorating economic growth prospects, and central bank officials' speeches leaning towards supporting a rate cut In addition, the European Central Bank will start a series of interest rate cuts in October 2024, reducing the rate by 25 basis points each time until June 2025, ultimately bringing the rate down to 1.75%. Overall, the ECB will cut rates by 175 basis points next year, while the market only expects a 145 basis point cut.

In this scenario, the Euro/US Dollar will face greater resistance. This is because the US employment report is strong, casting doubt on the Fed's rate cut in November, while the ECB is expected to cut rates again in October. The Euro's position as the best funding currency among G10 countries is further solidified.

In the stock market, despite the major European stock index Euro Stoxx 50 still being close to historical highs, a Nomura research report points out that investor demand for downside protection in the options market has significantly increased, indicating a growing awareness of economic downside risks in the market. This increase in risk aversion indirectly reflects market concerns about the economic outlook in the Eurozone.

Specifically, since mid-July 2024, the Euro Stoxx 6-month 10 Delta put option volatility has risen significantly relative to call option volatility, a change similar to market performance during the 2015 Eurozone debt crisis. Nomura analysis suggests that this may be an early signal of fatigue in the European stock market after a strong performance. If this trend continues, it will have a self-reinforcing negative impact on the Eurozone's economic slowdown.

Goldman Sachs: Economic Weakness, Diminished Inflation Pressure, ECB Dovish Stance Support Rate Cuts

Similar to Nomura's view, Goldman Sachs also believes that the ECB will announce a 25 basis point cut in the deposit rate at the meeting on October 17th. In a report on the 10th, Goldman Sachs indicated that this expectation is based on three main factors:

First, weak economic activity in Europe. Goldman Sachs points out that since September, economic activity data in Europe has further weakened. PMI saw a significant decline in September, with the composite PMI falling below 50. Surveys in countries like Germany, such as the Ifo survey, have also confirmed this weakening trend. Future surveys indicate a bleak outlook for economic activity.

Second, a slowdown in wage and inflation pressures. Goldman Sachs states that the slowdown in wage and inflation is faster than forecasted in September. Strong wage growth in the first quarter has cooled off in the second quarter, dropping from 4.7% to 4.2%, with an expected further decline to 3.9% in the third quarter. Recent inflation data also show greater progress than expected, especially with core inflation decreasing in September, expected to continue to be weak in October and November.

Lastly, the dovish remarks from the ECB further support rate cuts in the Eurozone. President Lagarde, in her speech to the European Parliament, pointed out that recent data has strengthened the Council's confidence in inflation falling to 2%. Other Council members also acknowledge the emerging downside risks to growth and broadly support a 25 basis point rate cut in October